The Economics of Deception

The following is a guest post by Robyn Allan, the former president of the Insurance Corporation of British Columbia who appeared with me on TVO’s panel about Dutch disease. It summarizes her recent paper: An Analysis of Canadian Oil Expansion Economics.

There is a chorus singing the praises of the oil industry and its vast economic benefits — from the boardroom of pipeline company Enbridge to the office of the Prime Minister. They advocate rapid expansion and export of crude oil resources as a panacea for our economic future. They cite big numbers from numerous studies.

The reports are used like quantitative billy clubs to beat back public inquiry and drive the discussion away from a thorough examination of macroeconomic implications. Instead, we have a forced narrative — industry financial gain must take precedence over environmental risk and First Nations’ rights. This is a false dichotomy.

The reports include Enbridge’s Application to the National Energy Board in support of Northern Gateway pipeline; Canadian Energy Research Institute’s (CERI) studies No. 122, 124, 125 and 128; the University of Calgary’s School of Public Policy paper, Catching the Brass Ring; and the Wood Mackenzie report prepared for the Government of Alberta.

The benefits range from hundreds of thousands of jobs and trillions of dollars in Gross Domestic Product (GDP) in CERI’s studies, $270 billion from Enbridge, $132 billion from the University of Calgary, and $72 billion from the government of Alberta.

These studies suffer from serious weaknesses which render the results not only unreliable, but unusable.

1. Input-Output Model: All the studies calculate a benefit without sensitivity analysis and develop a single long-term scenario. No board of directors would accept this approach when making an important investment decision, particularly when the rosy picture is forecast to continue for decades. All but Wood Mackenzie use this information as input into an Input Output (IO) model to further expand their case.

An IO model presents results as GDP, person years of employment, labour income and government revenues. Using these indicators of economic well-being gives the illusion that the model has measured macroeconomic impact, when the model has not — because it cannot.

IO models have severe limitations, over-estimate benefits and ignore economic costs. They do not perform a cost-benefit analysis. The underlying math constrains the models — they are static, linear, partial equilibrium representations of a sector of the economy at a point in time.

The models have no feedback mechanism so do not incorporate price, exchange rate, interest rate, or other input cost changes on the oil industry or the broader Canadian economy.

All the studies assume higher oil prices — rising to as much as $200 per barrel—but do not consider their impact on consumers as they cut back spending and saving, or businesses as they postpone investment, cut wages, and layoff employees.

IO models tell us the Vancouver Canuk riot was a wealth generating opportunity and — if jobs really matter — forget oil spill prevention and response. More person years of employment are created — per dollar — spilling oil than safely transporting it.

2. Exchange Rate: It is generally understood rising oil prices put upward pressure on the Canadian dollar. The studies ignore this. They assume a fixed and relatively low dollar over the long forecast period which inflates the benefit. Enbridge, Wood Mackenzie and the University of Calgary assume an 85 cent Canadian dollar. Their U.S. dollar revenues automatically receive an 18 per cent increase when translated to Canadian dollars.

An appreciating dollar hurts the Canadian economy. When the Canadian dollar goes up, the price of exports increase, foreign demand falls, and slower growth with job losses, follow. This phenomenon — when due to the expansion of the resource sector — is symptomatic of the Dutch disease. By holding the exchange rate fixed, the studies pretend a continued hollowing of our manufacturing sector does not occur.

Mention the Dutch disease and the oil industry and its proponents get defensive. However, even the oil sands are not immune to petro-fever. A rising dollar fundamentally affects profit performance of oil producers.

Crude oil sales are denominated in U.S. dollars while production costs are paid in Canadian. An increasing dollar squeezes profitability. For example, if the dollar is at par and oil sells for $100 U.S. per barrel, gross revenue is $100 Canadian. If the dollar rises to $1.05, that same barrel is worth $95.24 Canadian — a decline in gross revenue of 4.76 per cent.

Unless this relationship is included, estimates of financial returns, investment, and future supply, will be exaggerated. These unrealistic supply forecasts are then used to support the need for new pipelines to service the U.S. and China.

3. Oil Prices: Not only do the studies depend on rapidly rising oil prices, a number also require higher oil prices in Canada with new pipelines than without them. This perverse market outcome occurs because access to the higher priced markets in the U.S. Gulf Coast and Asia will allow producers to charge higher prices for the oil they sell in Canada.

Enbridge assumes the price lift with Northern Gateway is $2 – $3 U.S. per barrel, on every barrel — conventional to bitumen — every year for 30 years. The Brass Ring assumes $7.20 U.S. to $13.60 U.S. from 2016 – 2030 while the Wood Mackenzie Report assumes an $8 U.S. per barrel price increase on heavy oil sands production from 2017 – 2025. These price increases are on top of the studies’ anticipated doubling of oil prices over the next 30 years.

Refineries pass higher prices on and if they can’t, suffer reduced margins and may shut down. When refineries close, the price on petroleum products rises anyway because of lost production. Either way, Canadian consumers and businesses pay more because of new pipelines, and this needs to be incorporated into a macroeconomic discussion of their impact.

These deficiencies render the studies unusable. Their benefits should not be cited to expedite environmental review as they were in the Federal Budget 2012, demonize concerned citizens as Minister Joe Oliver has done on numerous occasions, or silence discussion of economic development challenges facing Canada as Alberta Premier Redford recently succeeded in doing in an open conversation with Ontario Premier McGuinty.

Economic growth in all parts of Canada is needed to ensure national progress. To realize this progress requires a courageous look at economic reality along with sound analysis — not a reliance on studies that enable the economics of deception.

3 comments

  • `Economic growth in all parts of Canada is needed to ensure national progress. To realize this progress requires a courageous look at economic reality along with sound analysis`

    That is the key to Canada! Why has Harper forgot that! This is the big Oil deception and ultimately it is insanity for an economic growth strategy for Canada. When was the last time you seen an oil rig or Mine outside of Toronto or Montreal- maybe 1810 or somewhere around there. We are not a resource based economy, we have several million workers in value added industries not remotely connected to the oil industry value chain.

    The grand illusion, and hey they are breaking every rule in the civilized books to develop that oil. This is insane leadership by Harper. The guy either has very little understanding of Canada and the economic union that brought us together and keeps us glued- or he must be blatantly trying to break up the country. He once told an audience of Americans that once he got into power, they would soon not recognize Canada – (my 11 year old son Andrew gave me that quote as he was researching a paper on Harper and his flag policy)

    Well economic unity is at stake right now, and I will say this, if we start falling off again in more unemployment and lose more good jobs in Montreal and Toronto and east, you will see some Canada bashing, and then we will have the Wild Rose bunch to deal with out west, things truly are going off the deep end with Harper.

    Maybe he is trying to destroy the country- who knows, I don`t think the guy knows a direction except oil.

  • And heck, that isn’t the half of it. If as you say there is no cost/benefit analysis involved, then whither opportunity costs? What kinds of things could the money and effort spent on oil expansion do if it were spent some other way?
    Again, the blithe talk of economic benefit vs. environmental damage carefully ignores the economic damage implicit in environmental damage. If spills end up costing more tourism and recreation long term jobs than the pipelines create in short term construction jobs, where is the employment advantage? Ruining a fishing stream is not an act with zero economic consequences. The only reason oil companies can prevail in such matters is that their gain is concentrated, while the losses are more diffuse and come from people with less surplus available to spend on lobbying and PR.

    And finally, say we agree that some sum of money gets generated. Who gets it? Oil is an industry in which windfall profits go to large corporations, often foreign-owned, and big shareholders; some goes to people with jobs in offices or in Fort MacMurray, but the proportion of the take going to ordinary people is low compared to most industries. If much of it goes to transnational corporations and foreign shareholders, does that sum actually enrich the Canadian economy in any way? How about amounts going to a small number of very rich Canadians who then turn around and invest much of it outside the country, after careful laundering through the Caiman Islands to avoid paying tax on it? How much does that money benefit the Canadian economy?

    Effectively, a given oil extraction project costs what it costs; the cost portion goes to actual workers, equipment purchase and so on. So if the price of oil is just high enough to make the project viable, the money generated represents the real economic benefit (before subtracting environmental costs etc). Figures above that largely generate rents for people and corporate entities who will not use it to the country’s benefit in any way. So the so-impressive dollar difference between assuming $200/barrel oil and $100/barrel or $60/barrel isn’t good for much except turning already fat cats into massive glandular monstrosity cats that crush the landscape beneath their bulk. Most of it should be clawed back as royalties.

  • PLG brings up a great point. Our (public at large) revenue from these projects does seem to be much less than the total. Some of it is funneled to already rich Canadian corporations and individuals, but worse, much of it ends up outside of Canada.

    I was just reading the Arun/Alan post and it occurred to me that the billions spent in support of the banks in the same order of magnitude of the investments we are asking foreigners to make in our natural resource development for which we then let them extract the profit. I’m not saying that protecting the banking sector from collapse was needed (I’m not an expert so can’t say for sure), but if we spent it there, can’t we spend it here for something that is definitely in the national interest.

    I noticed something odd in a federal spending/revenue pie chart recently. They list crown corporations as a decent size slice of the spending pie. You then have to look a little more closely to notice that revenue from crown corporations exceeds that spending. Maybe I mis-read or mis-interpreted. I’m not saying everything should be a crown corporation, just making an observation.

    There have been lots of discussions here recently about our natural resource wealth. I guess I’m just tired of watching our wealth being drained from under our feet while the majority of the country see’s little benefit.

    We decided to form a country some years ago. I read that as saying ‘we’re all in this together’, yet that doesn’t seem to be how we act. It would seem to be that in our 100+ year history, there were times when some current have provinces were have nots and this mix will likely change again going forward. Maybe we never shared well, though it seems to me that the polarization is higher today. IMHO, we need to be all for one to succeed going forward.

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